Depreciation as per the Income Tax Act A Comprehensive Guide
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Depreciation as per the Income Tax Act A Comprehensive Guide

Insurance Basics & Financial Advice Section 32 of the Income Tax Act of 1961 includes the provision for a depreciation allowance. According to this rule, a taxpayer may deduct depreciation from their use of tangible or intangible assets up to the real value of the asset being used. As per income tax depreciation rates and other regulations, depreciation deductions are only claimed by individuals for tax or accounting purposes.

Depreciation as per the Income Tax Act: A Comprehensive Guide

8 Minute |

Depreciation as per the Income Tax Act: A Comprehensive Guide

Depreciation under Income Tax Act

Section 32 of the Income Tax Act of 1961 includes the provision for a depreciation allowance. According to this rule, a taxpayer may deduct depreciation from their use of tangible or intangible assets up to the real value of the asset being used. As per income tax depreciation rates and other regulations, depreciation deductions are only claimed by individuals for tax or accounting purposes.

The goal of depreciation, as per the Income Tax Act, is to write off an asset's cost over its lifespan. Depreciation is also a required deduction in an entity's profit and loss statements. The Act permits deductions using the Written Down Value (WDV) method or the Straight-Line approach.

Both tangible and intangible asset depreciation is permitted as per income tax rules. In case the asset is tangible, one can claim the deduction against buildings, plants, and machinery. Alternatively, one can also claim a deduction for intangible assets like patents, trademarks, copyrights, licenses, franchises, and any other comparable business or commercial rights. Depreciation claims are subtracted from assets that the assessee used for business or professional purposes in the year before.

Block of Assets

To compute depreciation, one has to know the WDV (written down value) of an asset block. A group of assets from the same asset class are gathered together as a block of assets. They usually consist of the following:

  • Tangible assets like furniture, appliances, plants, and buildings.
  • Intangible assets such as patents, copyrights, trademarks, licenses, franchises, and any other similar business or commercial rights.

The asset block is recognised according to its type, life, and comparable applications. In addition, the percentage of depreciation within each asset class needs to be considered when classifying these assets. A block of the asset will be identified for each of these asset classes that have the same rates of depreciation.

Rates of Depreciation

The depreciation rate as per the Income Tax Act on assets is provided in the table below:

Assets Rates of Depreciation
Residential Building 5%
Non-residential Building 10%
Furniture and Fitting 10%
Computers and Software 40%
Plant and Machinery 15%
Personal Use Motor Vehicle 15%
Ships 20%
Aircraft 40%
Tangible Assets 25%

Depreciation Claims under the Income Tax Act

Here is a guide to claims for depreciation, covering classifications of assets, leases, property ownership, and other crucial details.

Assets Classifications

To receive the benefits of depreciation, the asset's owner must be an assessee. Both tangible and intangible assets can be taken into account for classification. Houses, factories, machinery, or furniture are examples of tangible assets. Patent rights, copyrights, trademarks, licenses, franchises, and similar property acquired on or after April 1, 1998, are examples of intangible properties.

Now, consider a scenario where depreciation is being determined by the income tax authorities for a house. While they may account for the property’s depreciation, it is possible that they may not consider the cost of the land on which it is situated. Why is this so? Land will not depreciate on account of wear and tear or usage. Hence, this is the justification for not including the cost of the same while calculating depreciation for the property.

Lease vs Ownership

Capital assets under ownership are the ones eligible for depreciation claims from assessees. The assessee has to be the owner of such properties to benefit from the depreciation allowance. Assessees can also get credit for properties built by them, even though they may be owned by others currently.

Used for Businesses or Professions

A business or occupation should have used any specific commodity in order to be eligible for the depreciation credit on the same. On the other hand, an assessee is not obliged to claim the depreciation credit, for which the asset must be used during the fiscal year. Consequently, the taxpayer is entitled to depreciation deductions even if he only uses the asset for a brief period of time throughout an accounting year.

On-Sold Assets

An assessee is not permitted to deduct depreciable assets. An object cannot be deducted by the assessee if it is sold, removed, or damaged in the same year that it was purchased.

Co-ownership

A co-owner of an asset has the option to record depreciation on the asset as well.

What are the Conditions for Claiming Depreciation?

There are several conditions for claiming depreciation, and they are listed below:

  • The assessee must be the sole or partial owner of the assets.
  • The assets must be used for the taxpayer's business or profession. If the assets are primarily used for purposes other than business, the depreciation allowed would be appropriately apportioned for business purposes. Section 38 of the Act grants the Income Tax Officer the authority to ascertain the proportionate fraction of the depreciation as well.
  • To the degree that each co-owner's assets are valued, co-owners may deduct depreciation accordingly.
  • Depreciation on goodwill and land costs cannot be claimed.
  • Since A.Y. 2002–03, depreciation as per income tax shall be allowed as a deduction regardless of a taxpayer's claim in the profit and loss account. Following the reduction of the depreciation amount, the taxpayer can carry forward the WDV.
  • The deemed profit is regarded to have taken the effect of depreciation into account if the presumptive taxation scheme is chosen.
  • The Income Tax Act and the Companies Act of 1956 have separate rules regarding depreciation. Consequently, regardless of the depreciation rate recorded in the books of accounts, only the depreciation rates stipulated by the Income Tax Act may be utilised.

Different Methods of Depreciation Calculation

Here are some of the commonly used methods to calculate depreciation.

According to the 1956 Companies Act On Depreciation, the methods are the following:

  • Written Down Value Method
  • Straight Line Method

According to the 2013 Companies Act, the calculation methods include:

  • Unit of Production Method
  • Straight Line Method
  • Written Down Value Method

According to the 1961 Income Tax Act, depreciation can be calculated with the help of the following:

  • Straight Line Method for Power Generating Units
  • Written Down Value Method (Block Wise)

FAQs - Depreciation under Income Tax Act

What is depreciation under the Income Tax Act?

Section 32 of the Income Tax Act of 1961 thoroughly addresses depreciation. Depreciation is the term used to describe how wear and tear reduces the value of any asset. Depreciation deductions are only claimed by individuals for tax or accounting purposes.

How is depreciation calculated under the Income Tax Act?

Depreciation can be calculated under the Income Tax Act in several ways. The common techniques employed are the Straight-Line Method, Write-down Value (WDV) Method, Unit of Production Method, Sum of Years’ Digit Method, and Double Declining Balance Method.

When an asset is sold, how do you measure depreciation under the Income Tax Act?

According to the Income Tax Act, the depreciation amount is calculated by applying the specified percentage to the asset's WDV. This is determined by its actual cost.

When can I claim depreciation?

The assets must be fully or substantially owned by the taxpayer. They also have to be utilised in relation to the business or occupation of the taxpayer. The permissible depreciation will be commensurate with the duration of time that the assets are utilised for business, even if they are used for non-business purposes, too.

Which method of depreciation calculation is used for tax purposes?

Tax depreciation is calculated through accumulated depreciation methods (e.g. the double declining method).

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